John Mauldin's Outside the Box : Middle East

Second Quarter Forecast 2009: Global Trends

John Mauldin — Thu, 23 Apr 2009 13:31:00 GMT

I've been in this business a long time. Some days it feels like a very long time. But never in all the years that I've been in the financial markets have I felt like business per se has less impact on my investment decisions. Let me explain.

GM shares have gone from being a claim on earnings from car sales to being a call option on whether the US government will extend another lifeline. Banks' capital structures have gone from being the province of Boards of Directors and CFOs to the "expertise" of Congressional committees and appointed regulators. Used to be when I thought about Financial Centers New York and London came to mind. Instead now I have to think about Washington and Brussels.

My friend George Friedman and his team at STRATFOR are where I turn when I need help thinking about these new realities. George's team provides me context and understanding of the environment in which financial developments are going to take place. I may tweak him about his ties, but if you saw George speak at my conference in La Jolla, you know that he's an absolutely compelling speaker. And it's small wonder that his latest book spent those weeks on the New York Times bestseller list too.

Below you'll find STRATFOR's 2Q Forecast. I hope you find it as helpful as I do in formulating my plans. What I can tell you with certainty is that if you're not taking into account the impact of geopolitical events on the markets, it's no different than trading agricultural futures without a weather forecast. George and his team provide their Members - myself included - with forecasts and on-going analysis that's invaluable in understanding the seachange in the global economy. And in exchange for me not teasing him any more, he's offering my readers a special rate on a STRATFOR Membership. Click here to join STRATFOR at this special rate and get access to a full year of the same geopolitical intelligence I use in my strategic planning. You'll be glad you did.

Yours, John Mauldin
Editor, Outside the Box

Second Quarter Forecast 2009: Global Trends

Editor’s note: STRATFOR arranges its primary forecasts — in this case the document below — topically rather than geographically. Thus, the entirety of our South Asia and Global Economy coverage for the quarterly is included in this primary forecast. Those portions of the Middle East and Eurasia forecasts that are not included in this forecast have been appended with the other regional sections.

Executive Summary

STRATFOR’s 2009 annual forecast focused on three broad trends: the global recession, the Russian resurgence and the evolution of the jihadist war.

There are number of indications that the U.S. economy is showing signs of life, but it will be weeks — if not months — before these glimmers may assemble into a firm recovery. At that point, it would be a minimum of an additional three months before a U.S. recovery could foster a global recovery. This means that for the second quarter, STRATFOR is able to take a pass on this part of our forecast. Either this quarter will be the dark before the dawn, or it will be the dark before midnight. Either way, it will be dark. A noticeable recovery will have to wait until the third quarter.

In the first quarter, Russia was convinced that it had the new U.S. president and his administration right where it wanted them: so obsessed with the Afghan war that Russia could demand anything it wanted in exchange for allowing military supplies to enter Afghanistan from the north. Russia miscalculated. It seems the Obama administration puts something above fighting the Afghan war on its priority list: limiting Russia’s resurgence. The second quarter will be Russia’s time to consolidate the advances it has made over the course of the past four years, before the Americans can gain any capacity from their planned Iraqi drawdown. Washington will be looking for ways to bolster allies against Moscow, with a somewhat ambivalent Turkey taking center stage.

Finally there is the jihadist war itself. The U.S. divide-and-conquer strategy has worked reasonably well in Iraq: Some Sunni militants, rather than shooting at U.S. forces, are now being integrated (after a fashion) into the fragile yet strengthening Iraqi federal government. This is allowing the United States to remove some forces from Iraq, and thus to surge some into Afghanistan. The American intent is to rework the divide-and-conquer trick on the Taliban. However, this tactic is not likely to be replicable for a mixture of historical, demographic and geographic reasons. The most likely reason for the plan to not succeed is because in Iraq, the “good” Sunnis the Americans courted were locals — nationalists under pressure from Shiite Iran — while the “bad” Sunnis were foreign Islamists. In Afghanistan, there is no neat factional split within the Taliban. So for the Americans, the next three months will be about trying to force a square peg into a round hole. There will be little if any progress, and the Pakistani government’s lack of enthusiasm for the conflict will allow the region’s militants to expand the scope of the war.

Primary Forecast

Global trend: The Economy

Undoubtedly, there is plenty of bad news — stock market surges tend to be the first major sign that the U.S. economy is healing, but the stock market cannot seem to find its feet, and employment remains well off ideal levels. Yet in the latter half of the first quarter, there were several developments indicating that the credit chokehold that caused the American recession to go global has begun to slacken. The availability of credit is the critical issue when evaluating this recession. Until firms and consumers can reliably borrow, economic growth cannot recover.

There are limited signs that credit is indeed loosening, and that some life is creeping back into the U.S. economy. Recent changes in accounting rules in the United States and Europe should grant banks the confidence they need to resume lending, independent of anything the governments might attempt. The Obama stimulus package — albeit far from perfect for actually stimulating the economy — is beginning to take effect. Retail sales have been surprisingly buoyant and since consumer spending comprises 70 percent of the American economy, this is a critical factor. Even more important is the fact that the stock of inventories has dropped for six consecutive months (September 2008 to February 2009, the latest month for which data is available) in the steepest decline on record. With inventories low, producers will soon be getting orders. That is how economic recoveries begin. There are even flickers of activity in the most moribund U.S. economic sector: housing.

But even if the United States economy is indeed showing signs of life, four caveats must kept in mind.

First, even a robust resumption in U.S. growth will not begin on any specific date. Instead, there will be increasingly bright glimmers of light here and there that will not be fully recognized until six months after the fact. It appears that the second quarter may be a transition quarter for the United States, with the more noticeable growth happening later in the year.

Second, the future of the American automotive industry his shifted from bleak to dark, with General Motors Corp. in particular planning for imminent bankruptcy (and GM is not the worst off of the Detroit Three). The dislocations caused by this industry’s implosion will be felt far and wide and even if they somehow do not delay the recovery, they are certain to have a material impact on how serious the average American views the recession as being.

Third, a resumption in growth in the United States historically does not mean an immediate rebound in either income or employment figures — both tend to be lagging indicators — particularly if the automotive industry breaks apart. Therefore, even if the recession does let up in the second quarter and growth turns nominally positive, that does not mean that most Americans will feel like the situation has improved. Bear in mind that it did not become conventional wisdom that the United States’ 2001 recession — which actually ended in October 2001 — had ended until 2004. Dispelling Americans’ mental gloom required more than two years of strong and sustained growth.

Fourth, while STRATFOR is certain that the U.S. economy will lead the world out of recession — the roughly $10 trillion American consumer market will demand products from, and thus generate growth in, Asia and Europe — STRATFOR is equally certain that there will be a lag of one to three quarters between a U.S. recovery and a global recovery. Most of Asia has suffered export plunges of at least 50 percent, and industrial output is down by a third the world over. Even if the Americans already have eaten through existing inventory, it will take some time for foreign suppliers to spin their industrial bases back up. The global system does not turn on a dime.

This means in the quarter ahead STRATFOR actually gets to opt out of taking a hard stance on this issue. If the United States does not recover, the world will remain mired in recession. If the United States begins to recover, the world will remain mired in recession and will begin pulling out later in the year. Either way, the second quarter is not going to be a comfortable time; it just might be slightly less uncomfortable for the Americans.

Internationally, there will be only one force aside from the U.S. economy to watch: the International Monetary Fund (IMF), which was recapitalized at the April G-20 summit to handle the growing need for bailouts. The IMF’s assistance programs can be split into two parts. First, traditional structural adjustment programs will provide funds to states that have made poor economic decisions. These states then fall under the IMF’s tutelage, and they must make often-wrenching changes to how their systems are run. States tapping this sort of loan program include Ukraine, Hungary, Iceland, Sri Lanka and Pakistan. These states in essence are on a sort of life support while undergoing economic surgery.

The second kind of program — introduced in March — is a bridge loan for states that have been doing a decent job of economic management but are affected by factors related to the recession that lie utterly beyond their control. This second type of program does not require any meaningful changes to a state’s economic management as (in the IMF’s eyes) they have not done anything wrong, and could perhaps be extended to countries like South Korea, Brazil, Mexico and Poland. It is this second sort of program that will have a deeper effect on the system in the short run as it will allow larger states to maintain economic activity independent of the United States, somewhat blunting the effects of the recession without threatening social stability. It is also going to absorb the lion’s share of the IMF’s funding; the first program negotiated under this system — a $40 billion line of credit to Mexico — is two-thirds as large as the combined total of the more traditional loans granted since the crisis began.

Global trend: The Russian resurgence

In STRATFOR’s 2009 annual forecast, we outlined how a dominant issue for the year would be Russia’s effort to force the United States to make a strategic bargain: Russia would grant U.S. forces a northern supply route into Afghanistan in exchange for an expunging of Western influence from the former Soviet space. At a series of summits in the first week of April, the Obama administration broadly rebuffed Russia’s demands, and the two states are sliding quickly into confrontational stances.

From the U.S. point of view, Russia has overreached and has failed to consolidate its position in the key former Soviet spheres it assumed were under its control. From the Russian point of view, the U.S. refusal to accept Russia’s superior position has forced Moscow to redouble its consolidation efforts in order to erode Washington’s confidence and limit Washington’s future options inside the former Soviet sphere.

Russia will make three major consolidation efforts during the next three months. First and most important, Moscow will try to manipulate Ukraine to remove pro-Western elements such as Ukrainian President Viktor Yushchenko from power. Second, Moscow will undermine the Georgian government to destabilize pro-Western elements there. Georgia, unlike Ukraine, is solidly pro-Western, so Russia is satisfied simply to destabilize or neutralize it rather than transform it into something useful to Moscow. The deck is stacked in the Kremlin’s favor in both states due to Russia’s overwhelming energy, intelligence, political, economic and cultural influence, as well as geographic proximity.

But it is the third consolidation attempt where things will get tricky: Armenia.

Turkey and Russia’s spheres of influence overlap in many regions, including the Caucasus. Not only is Russia very active in Georgia, but Turkey — as part of its efforts to relaunch long-dormant geopolitical ambitions — is trying to normalize relations with Armenia. Turkey ended relations with Armenia in 1993 after Armenia began its war with neighboring Azerbaijan over the secessionist Armenian region of Nagorno-Karabakh located inside Azerbaijan — and the Turkish-Azerbaijani relationship has only strengthened (especially against Armenia) since then.

However, the normalization of relations between Turkey and Armenia would open the Caucasus to a flood of Turkish political and economic influence. Until now, Moscow has actually facilitated this process, thinking that a grateful Turkey would not side with Europe and particularly the United States in containing Russian influence. Now that U.S. President Barack Obama has personally forged a partnership with the Turks, the Kremlin is not so sure.

The restoration of ties between Turkey and Armenia was rumored to occur in the first week of April, though now dates for the event range from May to October. Russia has many levers, including energy, which it can use to counter Turkey’s orientation toward the Americans, including Moscow’s power to decide whether its protectorate of Armenia will go forward with any deal with Ankara.

The wild card in talks between Turkey and Armenia is Azerbaijan. Baku — which considers Yerevan its worst enemy — feels that its close ally Turkey has abandoned it and wants to ensure its interests are not overlooked in any deal between Turkey and Armenia. Baku is considering two means of scuttling the talks, both with the intent of severing growing Turkish-Armenian ties: appealing to Russia (the logic being that Turkey does not wish to simply trade energy-rich Azerbaijan for energy-poor Armenia), or directly attacking Armenian-held territory (triggering a war in which Turkey would feel forced to take sides).

Global trend: The U.S.-jihadist war

While STRATFOR maintains that the overall strategic threat posed by the transnational jihadist movement continues to wane, the U.S.-jihadist war, which stretches from Iraq to the Indian subcontinent, remains a dominant theme for 2009.

The United States has no choice but to wrap up the war in Iraq so that it can devote more resources to the war in Afghanistan, but the transition from the Middle East to South Asia will not be easy. A fragile power-sharing deal among the Shiite, Sunni and Kurdish power groups remains intact, and violence levels are still low. Yet, as STRATFOR expected, the United States is facing difficulties ensuring that the Shiite-dominated Iraqi government is integrating into the security apparatus members of the Sunni militia forces that split off from al Qaeda and allied with the United States. Shiite-Sunni tensions will continue to simmer. Al Qaeda in Iraq (AQI), while a much-weakened force, may still appeal to dissident Sunnis — which may allow AQI to regain space and carry out more attacks.

Kurdish-Arab tensions are also likely to escalate over the next several months. Kurdish claims to the oil-rich city of Kirkuk and constant political maneuvering among Sunnis, Kurds and Shia (most notably involving the Iraqi prime minister) could ignite the dispute over Kirkuk’s future for political gain. In addition, political infighting within the Patriotic Union of Kurdistan (PUK) is likely to worsen as PUK leader and Iraqi President Jalal Talabani prepares for his succession.

The United States will try to improve its chances of holding Iraq together internally by laying the groundwork for a more constructive relationship with Iraq’s Persian neighbors. On the surface, the U.S.-Iranian relationship is improving: Obama has made clear his intent to engage Iran; his administration has agreed to direct, multilateral talks with the Iranians on the nuclear issue; and Iran is participating in U.S.-led summits on Afghanistan. But beyond the rhetoric, little has changed between Tehran and Washington. Iran is more likely to ratchet up ambiguity and Western anxiety over its nuclear program than make concessions to Washington. Like AQI, Iran’s influence may have slipped, but it has not evaporated: Iran’s influence with Shiite militants remains strong enough to upset the delicate Sunni-Shiite balance the Americans are counting on holding.

Iran is also unhappy with the developing U.S. strategy in Afghanistan that calls for engaging with “moderate” members of the Taliban — a radical Sunni force that Tehran regards as a strategic threat. Tehran will keep up appearances in the diplomatic sphere but will continue to keep its distance from Washington on any issues of substance in the near term. Iranian presidential elections will be held in June, but regardless of which camp the winner comes from — hard-line, moderate or reformist — Iran’s foreign policy goals and concerns are unlikely to shift significantly.

Meanwhile, Washington will shift its focus to South Asia even though there are evidently many loose ends to tie up in the Middle East. The developing U.S. strategy for this region will focus on bolstering the U.S. forces in Afghanistan, negotiating with moderate Taliban and diversifying supply routes to deny Pakistan some of the leverage it holds in this war. However, this plan suffers from a number of strategic flaws.

The second quarter will be a trying one for U.S. forces in Afghanistan. The initial surge of 21,000 troops into Afghanistan will not be in place until summer’s end. Though European NATO members have contributed additional forces to help secure the country for elections in August, most are temporary commitments and do little to alter the overall U.S. and NATO force structure being directed at a native guerrilla force with superior local knowledge and intelligence. This puts NATO on its heels in combating Taliban and al Qaeda forces, which will use this spring fighting season to shape the battlefield, carrying out operations in the countryside that aim to expand their territorial control and launching complex attacks in urban centers that aim to degrade the confidence of Afghan civilians and security forces.

American attempts to elicit cooperation from Pakistan through aid packages are unlikely to affect Pakistani behavior significantly in the near term. Though Pakistan is threatened by a separate Taliban insurgency at home, it prefers negotiations over force on its side of the border. This gap between U.S. and Pakistani policy in managing the insurgency will become more evident in the coming weeks and months as Pakistan fends off U.S. attempts to overhaul the Pakistani intelligence apparatus and makes agreements that undermine the writ of the Pakistani state in its northwest periphery. Pakistan’s preference to avoid combat will allow Taliban forces to concentrate their attacks on the U.S. and NATO supply routes that originate in the port of Karachi.

The United States had attempted to diversify its supply lines by opening up a northern route that enters Afghanistan through Russian-dominated Central Asia, but talks have frozen as U.S.-Russian relations deteriorate. The United States is now almost completely dependent on Pakistan; the logistical burden is rising with support for the troop surge, and the militants feel emboldened as Pakistan feels it can use a lighter touch in combating them.

India’s concerns will rise as little progress is made in the war.

As STRATFOR forecasted in the 2009 annual, New Delhi has refrained from taking overt military action against Pakistan after the November 2008 Mumbai attacks for fear of destabilizing Pakistan further and giving regional jihadists an excuse to focus their attention on India. Yet the gradual unraveling of command and control within the Pakistani military establishment has enabled many more of Islamabad’s Islamist militant proxies operating in Pakistan and India to team up with transnational jihadists to carry out deadlier and more strategically targeted attacks. Though the timing is uncertain, India is likely to witness another large-scale Islamist militant attack on its soil that will once again escalate cross-border tensions on the subcontinent.

India has thus far stayed on the sidelines of U.S. dealings with Pakistan and Afghanistan. Its involvement is largely limited to two items: first, making clear to Washington that Kashmir is not up for debate as Washington attempts to rehabilitate Pakistan, and second, increasing its presence in Afghanistan, devoting effort to reconstruction projects and perhaps providing covert support to anti-Taliban groups in the north (in part to counter a U.S. strategy to engage “pragmatic” Taliban). Much like the Iranians and the Russians, India has no interest in engaging Taliban forces who share a Pashtun link with the Pakistanis.

India is currently in the midst of a general election that will conclude in mid-May. No party is likely to win a clear majority, and it will be up to the incumbent Congress party and the main opposition Hindu nationalist Bharatiya Janata Party (BJP) to cobble together a ruling coalition of smaller regional parties. STRATFOR will not attempt to predict the outcome of this uncertain election, which will largely be based on the populist votes of India’s lower classes, but should the BJP manage to overcome its setbacks and take the lead, Indian restraint against Pakistan would not be assured in the event of another large-scale militant attack.

Part Two: Second Quarter Forecast 2009: Regional Breakouts

Iran: Using Oil as a Weapon, But Only Rhetorically

John Mauldin — Thu, 08 Jan 2009 15:33:13 GMT

Dear Friends:

The hottest media topic of the New Year is the Israeli-Palestinian conflict in Gaza. And as I was reading the New York Times on Tuesday, I came across this sentence in one of the articles that was staggeringly truthful and more than a little unsettling in its implications for me as an investor.

"There are other ways to construe the context of this conflict of course. But no matter what, Israel's diplomats know that if journalists are given a choice between covering death and covering context, death wins."

Now, I'm NOT trying to get into a debate about the rights and wrongs of either side, but if you're an investor, and you're trying to make decisions about where this conflict might drive oil prices, for example, then context is everything. And according to the New York Times, if you're relying on journalists for context, forget it.

But you do have an alternative: my friend George Friedman's company, Stratfor, is the unbiased source for insightful analysis of global events. George and his team are all about context – and they provide it without bias or an agenda. If you're my age, you remember "Just the facts, ma'am." Whether it's the conflict in Gaza, the war between Georgia and Russia, or the mayhem and violence in Nigeria, when I need to know how geopolitics is going to hit energy prices, I turn to Stratfor.

I'm including today one of their analyses on the conflict: Iran: Using Oil as a Weapon, But Only Rhetorically. In it, Stratfor showcases its strengths: unbiased analysis--and in this case, of a situation mainstream media has barely even registered. George has kindly arranged a special offer for my readers. Click here, and you'll get 2 years of Membership for the price of 1 for just $349. Plus George is including a free copy of his new book coming out later this month (I'll be reviewing it for you in a couple weeks.)

Your all-about-context analyst,
John Mauldin

Iran: Using Oil as a Weapon, But Only Rhetorically

Summary

Iran is calling for oil-producing states to launch an embargo against the West in protest of Israel's current military operations in Gaza. But while Tehran would love to see oil prices rise, it is in no position to cut production -- and neither, really, are its Arab neighbors. In reality, the embargo threats are mere atmospherics in the ongoing geopolitical rivalry between Iran and Saudi Arabia.

Analysis

Brig. Gen. Mirfeysal Bagherzadeh, a commander of Iran's elite Islamic Revolutionary Guards Corps (IRGC), on Jan. 4 called on Muslim countries to use oil as a weapon to end the ongoing Israeli offensive in Gaza, now in its 10th day. Bagherzadeh said Western dependence on the energy resources of the Islamic world should be used to put pressure on Israel's backers in Europe and the United States. His remarks come on the heels of similar calls from lawmakers in Bahrain, a country whose political landscape is dominated by its Shiite majority, which in turn has ties to Iran.

For a variety of reasons, however, such calls will not spark any serious attempts to use oil as a means to affect the Israeli-Palestinian conflict. Indeed, Iran's real purpose is not to spearhead an oil embargo against the West, but rather to score political points by emphasizing publicly that Tehran is the only player in the region trying to support the Palestinians during an Israeli military offensive. The primary goal is to make its Arab rivals look bad -- especially Saudi Arabia and its allies in the Gulf Cooperation Council. (Though if the markets were spooked by the threat and oil prices jumped, the Iranians would not mind at all.)

Tehran actually is no position to come to the aid of the Palestinians; only Saudi Arabia and the other, smaller Persian Gulf states would be able to make such an embargo work. These countries are more concerned about their bottom lines, however. At a time when the world is in the middle of a major financial crisis and the price of oil has fallen by some 70 percent from the record highs of July 2008, they need to sell oil just as much as the West needs to buy it. That is why Saudi Arabia, the main mover and shaker in the Organization of the Petroleum Exporting Countries (OPEC), is already having a hard time getting the other cartel members to abide by recently announced production cuts aimed at raising the price of oil to more acceptable levels.

The petroleum-rich Arab states still have massive reserves to keep them financially healthy for quite some time to come. In contrast, the Iranians are hurting badly from the slump in oil prices and desperately need more income. Thus, in reality, Tehran has much more to lose by cutting production than its Arab rivals do. And because of sanctions, Iran does not even sell oil to the United States -- so there is nothing Tehran can do to "implement an embargo" against the world's No. 1 oil consumer.

But Iran is hoping its threat will kill two birds with one stone, pushing prices up even if there is no embargo. Despite their long slide, oil prices have jumped some 25 percent in the 10 days since the Israeli operation began. It is not clear that this increase is actually related to the Gaza operation -- after all, Israel produces a mere 5,966 barrels per day (bpd) of oil, consumes only about 250,000 bpd and transits nothing worth mentioning. But Tehran is hoping that the markets are spooked, and that they will be spooked further by the threat of an embargo.

For oil prices to be affected significantly, however, the oil-rich Arab states would need to join Iran in making an issue of the Israeli operation -- which they are not doing. On the contrary, they are hoping that the assault will cut Hamas down to more manageable proportions and thwart Iran's attempts to use the Israeli-Palestinian conflict to its own advantage.

Fourth Quarter Forecast 2008

John Mauldin — Thu, 30 Oct 2008 17:57:08 GMT

Really hear what I'm about to tell you. The center of gravity of the world economic system has moved from New York to Washington. Let me illustrate what I mean so you understand just how profound this is. Banks used to compete against banks. US carmakers competed against each other and the Japanese. And the New York financial markets told you how they're doing against each other.

Understand what's happening now. The US Treasury has become the only "customer" that matters. The Treasury is now the customer—and investor -- with the $750+ billion checkbook. The Treasury is now the "investment banker" of last resort, arranging and financing mergers. Banks are competing against insurance companies for their slice of the bailout pie. Chrysler and GM (and the Michigan Congressional delegation) are looking to Washington, not Goldman or Merrill, to facilitate a merger. This is a seismic shift.

As investors, we have to start looking at the world in a completely different way, and getting our information from different sources. A company's 10-K is almost irrelevant if all it includes is financial statements and market outlooks. What matters now are the "exogenous" factors: government guarantees of the commercial paper market, currency interventions, direct capital infusions, etc. And how does a company describe in its Management Outlook that "Yes, our company is too big to fail."

In this environment, it's more important than ever to read unbiased geopolitical intelligence and analysis of government moves, and that's what my friend George Friedman at Stratfor offers. I'm enclosing below his team's Fourth Quarter Forecast. George's team analyzes US government policy as well as the moves that are being taken by central banks and governments around the world as the private sector gets taken public all across the globe. You will not be able to understand market moves if you don't understand who the real movers are now.

I'm sending you Stratfor's Fourth Quarter Forecast, and I strongly encourage you to join Stratfor and get access to all their daily intelligence. George has arranged a special offer on a Stratfor Membership for my readers: click here to take advantage of this opportunity. In this new era, I use Stratfor daily to give me a wide-lens, global view of politics and economics. I know you'll gain as much from reading Stratfor as I do.

John Mauldin

Fourth Quarter Forecast 2008

October 23, 2008 | 1502 GMT

Three issues will dominate the final quarter of 2008: the global financial crisis, U.S. self-absorption and the Russian resurgence.

The financial crisis has its roots in an American liquidity meltdown. But as the days flow by, it will become obvious that the crisis is evolving as it spreads to the rest of the world, and its impact will be harsher and require more time for recovery elsewhere. For in the United States, actions have already been taken to rectify the liquidity imbalances, and although plenty can still go wrong and a recession is probably inevitable, the system is beginning to mend. In Europe, however, the liquidity shortage has unearthed a deep banking debacle.

Remediation is only now being started, and the problem is only now being identified, much less evaluated. The American recession will probably be over by year's end, but Europe's will likely stretch through most of 2009. And in East Asia, where the problem is neither liquidity nor banking but loss of export demand, recovery cannot even begin until the West begins demanding Asian goods en masse. The United States might have set the crisis running, but it will be Europe and Asia that really give it its legs.

Print Version:
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In the midst of a presidential election, a lame-duck administration, a recession and ongoing efforts to stabilize Iraq, Washington is essentially in lockdown. It has neither the capacity for nor the interest in dealing with anything that is not on a very short list of topics. Mitigating the recession is now at the top of that list, with Iraq second in line. In Iraq, U.S. policy has mutated somewhat. Until now, Washington was forced to deal with Iran, as Iran maintained the ability to scuttle any progress in Iraq. But now Iran, for various reasons, has largely moved away from its policy of stoking militia fires in Iraq. It would be a stretch to say that all concern about Iran's ability to set Iraq on fire has evaporated, but Washington certainly feels it can shape Iraq into more or less whatever it wishes so long as it does not flagrantly cross any red lines. This does not mean for a second that things are easy; creating a functional state out of the Shiite, Sunni and Kurdish populations is a lengthy and possibly fruitless task. However, Iran's apparent inability to create chaos in Iraq has drawn some of the desperation out of U.S. policy.

Finally, and to a certain degree integrated into the financial crisis and American preoccupation, comes the issue of Russia's rise. In the third quarter Russia proved that it remains capable -- militarily and politically -- of invading a neighbor, the former Soviet state of Georgia. While not immune to global financial chaos, Russia is far better prepared than most states to weather the storm; even after massive investment outflows, Russia still holds more than $700 billion in reserve funds and a fat budget surplus. Moscow has a limited window in which to act before the United States withdraws from Iraq and turns its attention northward, so Russia will be using the time to sow as many problems for the United States as possible. Russian plans are already in the works for Latin America, the Middle East and Africa, in that order. And to keep the pressure on and the momentum going, Russia is expected to make a new thrust -- more political and economic than military -- in Ukraine. Under the cover of the financial crisis (which is hitting Europe much harder than the United States) and American preoccupation, the chances of Russia successfully expanding its influence definitely qualify as betting odds.

Note to readers: Our fourth-quarter forecast is intended to be a supplement to our annual forecast and third-quarter forecast. Within each section of this quarterly we have extracted the critical trends identified in our previous forecasts and indicated where we have been right or wrong and what is coming in the next three months. We have also examined new trends that have evolved from regional developments, independent of the earlier forecasts.

Global Economy

Ultimately, Stratfor delayed the release of our fourth-quarter forecast due to the winds of change ripping through the U.S. financial industry. With so much uncertainty, it was impossible to peer minutes, much less months, into the future. But now, though the dust is far from settled, the outlines are in place for an American-led financial rescue package that puts the crisis into a context that allows for forecasting.

This section will not serve as an overview on how the crisis came about (we have written a history and tactical forecast on the financial crisis elsewhere), but it will outline the broad picture Stratfor sees in the weeks going forward.

Regional trend: The United States is in a liquidity crisis, but the fundamentals of the U.S. economy remain strong. Overwhelming state intervention will ensure that the United States recovers quickly from an impending, and probably inevitable, recession.

In the United States, the crisis is ultimately one of liquidity. Underneath all the froth, the American banking system remains stable. Yes, there are some questionable assets that have initiated panic, but on the whole American banks are solid. Before the political process in Washington took over the system and in essence made it impossible for banks to close, only 13 banks had gone under. During the recession of the early 1980s, several hundred went bust per year.

Liquidity crises are relatively -- and we emphasize the word "relatively" -- easy to fix. They "only" require injections of capital into the system, which the U.S. government has done on a mammoth scale, in order to restart lending and thus normal economic activity. At the time of this writing, banks have already increased their lending rates from the crisis lows, and we see the panic beginning to lift within weeks. For the United States, there will almost certainly be a short recession, but the way out has already been sketched.

Regional trend: With Europe dealing with a deeply entrenched banking crisis and Asia facing a plunge in exports, the financial contagion will be more deeply felt outside the United States than within.

When the U.S. liquidity crisis slammed into Europe it had identical impacts -- at first. But within a few days, it became apparent that Europe has other problems. Unlike the United States, Europe has a banking system with many portions that are not very healthy. Austrian, Swedish and Italian banks are overexposed to Central Europe, which is now in a credit hangover. German banks' corporatist links have left them with questionable assets far greater in value than anything American subprime practices generated. Irish and Spanish banks face much deeper subprime problems relative to their economic size than American banks. And the list goes on and on. So while the United States has a liquidity crisis that can be addressed "relatively" easily, Europe faces a banking debacle that has been uncovered by the liquidity crisis -- and dealing with that banking debacle is likely to take more than a year.

These crises have not really affected Asia directly, for Asian states are built upon massive and artificial flows of liquidity. States routinely funnel more liquidity into their systems than even the U.S. Federal Reserve is doing with its record-breaking operations to combat the American liquidity crisis. So even with the United States and Europe struggling, there are very few liquidity problems in China or Japan.

The Asian problem will be neither liquidity nor banking, but exports. The United States faces a short recession and the Europeans likely a long one. For Asian economies, the problem will be a plunge in Western demand for Asian exports that will hit these economies at their most sensitive point: employment. China and Japan keep their systems flush with liquidity in order to ensure maximum employment regardless of profitability. As Western growth slows, demand for Asian goods will drop, and the Asians will have to either shut factories down or subsidize them to keep operations active. Luckily -- and we are not sure that "luckily" is the correct word -- this will take some time. We do not expect East Asia to really slide into crisis mode until late in the fourth quarter, but the crisis will strike the region to its very core.

Regional trend: Inflation is on the rise on a global scale.

High inflation was the primary economic issue for countries across the globe for the first nine months of 2008. Overextension, combined with a deepening economic crunch, will finally turn this trend on its head in the final quarter. Across the developed world, demand is dropping, and that cannot help but put a cap on commodity prices.

Regional trend: The global financial crisis' contagion will contribute to a significant decline in the price of oil and defuse much of the "geopolitical heat" in the markets.

Let us close this section with a few words on oil. Stratfor has been saying for some time that the high oil prices of the last three years are not rooted in fundamentals or even in reality in general, so we stopped forecasting any specific prices. In our last quarterly forecast, we said the price of oil would drop (and it did), but we were focused more on causes rooted in geopolitical risk rather than the effects of the financial crisis. At present, much of the speculative froth and fervor that had built up prices has been dying down. In its place is a growing realization that the United States and Europe are in recession, while East Asia is about to slip into recession. With the world's three largest economies using less energy, prices are certain to slide. This realization is dawning only now, when prices have already dropped from their highs by 50 percent. The hype is mostly gone; all that remain are universally bearish fundamentals. The price drop to date is just the beginning -- and several countries, including Venezuela and Russia, stand to lose a lot from a precipitous drop in oil prices.

Former Soviet Union

Regional trend: Russia is re-emerging and will take advantage of the imbalance in U.S. power that has resulted from the wars in Iraq and Afghanistan.

Russia's third quarter was dominated by the war with Georgia, which was Moscow's coming-out party to prove that it could dominate and/or crush its neighbor unless the United States rushed to the smaller country's aid. The Kremlin had been making technical preparations for such a war for years, but timing was an issue. Moscow was forced to act in the third quarter because of the possibility that the United States might be freed from its entanglements with Iran and in Iraq. Since the war in August, the ripple effects of Russia's bold move have been felt throughout the world, but they are most defined in Russia's periphery. As each country re-examines its relations with Russia, Moscow is taking stock of the levers it has carefully placed in its periphery and around the world and considering who it can pressure, or even break.

Regional trend: Following the Russo-Georgian war, each former Soviet state -- and much of the rest of the world -- is redefining its relationship with or perception of Russia. Moscow will next turn its focus to Ukraine, which will become the center of the Kremlin's universe in the fourth quarter.

The center of Russia's focus for the fourth quarter is Ukraine, which Moscow sees as the cornerstone of its ability to reach into Europe and protect itself from Western encroachment. Since the 2004 Orange Revolution, Ukraine has been unstable and chaotic in its attempts to push away from its former master, Russia, and toward the West. Moscow has encouraged Ukraine's instability as a means of preventing the former Soviet state from aligning fully with the West, but now is the time to pull Kiev firmly back into the Russian fold.

Russia will use countless levers to influence Ukraine's inner dynamics, including: the Russian security services' high degree of infiltration in Ukraine; the country's complete dependence on Russian energy; Ukraine's financial and economic turmoil; Russia's control over most of the Ukrainian oligarchs; the interconnection between the two countries' organized crime systems; Russian military forces on Ukraine's soil; and the mere fact that approximately half the Ukrainian population considers itself beholden to Russia.

But the largest opportunity for Moscow will come in the December snap elections, scheduled after the Ukrainian government collapsed (again) in October. Elections in Ukraine are never certain to take place, but the dynamic surrounding possible elections in the country will remain whether or not the polls actually take place. The pro-Western Orange Coalition has already broken up over Kiev's relationship with Russia, and those coalition partners who are leaning back toward Moscow, along with the pro-Russia parties, are in a healthy lead in public opinion polls. Ukraine has never been predictable, but it also has never seen an election or governmental shift while Russia's full focus is on ensuring that Ukraine stays as far away from the West as possible.

A few other former Soviet states are on Moscow's agenda, though they are not as high-priority as Ukraine. Georgia's government is still seeing the fallout from the war, and Georgian President Mikhail Saakashvili's future is unclear. Russia has allowed Saakashvili to remain in office because he is a spent force, but the Kremlin has a line of political forces in place to remove him should he gain strength. Russia and Belarus spent much of the third quarter arguing over energy prices, bank credits, missile defense and Minsk's delay in recognizing the independence of Georgian breakaway regions Abkhazia and South Ossetia. The fourth quarter will be a test for Belarus as it decides whether to bend to Moscow's will or risk reaching out to the West and being crushed by Russia in the process.

Russia is also active in the Baltic states. An upcoming election is likely to leave Lithuania with a government more amenable to Moscow, but it remains to be seen how this new government will fit in with Lithuania's historical allies -- Poland, Estonia and Latvia, which are all vehemently anti-Russian -- and how Moscow can use the new government to divide that allied bloc. Azerbaijan is weighing its future relations with Moscow, since Russia has proven it can cut off the country's energy flow, which in turn cuts off its cash source. Baku will work to balance its desire to maintain good relations with Moscow and its desire to keep Western cash flowing in.

Regional trend: The global financial crisis is ripping through Russia, but it is not crippling the country. Rather, the Kremlin is using the situation to assert more control over regulations, banks, businesses and the oligarchs inside Russia while looking for opportunities abroad.

Market economies do not work in general in a country like Russia. Since the Russo-Georgian war, the Russian stock markets have been on a wild roller-coaster ride, and Russian companies have seen massive foreign investment flight. This has left those companies and their oligarchs looking for funding in their own pockets or from the state. But unlike most countries, Russia is not in danger of collapsing financially, because it sits on massive amounts of foreign currency reserves, built up over the past decade from soaring energy prices.

Instead, the Kremlin is using the unstable financial situation to reassert the primacy of the Russian state by weeding out small- and medium-sized institutions that were never really under government control. The Kremlin is also using the situation to force the oligarchs to pour their own cash -- which they had stored abroad, far from the Kremlin's grasp -- into the system in order to keep the markets stable and the oligarchs' companies afloat.

This proves just how much control Russian Prime Minister Vladimir Putin has over this class of billionaires, and it bodes an end to the oligarchic tradition that ruled Russia during most of the 1990s and well into the following decade. The oligarchs are no longer independent power brokers, but simply another tool -- and a very wealthy one -- for Putin and the Kremlin. The fourth quarter will start revealing who can keep up with the Kremlin's demands and who will fall. A massive realignment inside Russia's business sector is under way, though the Kremlin is orchestrating all of it in order to strengthen and prove its power within the country -- and over those who thought they could keep their cash outside the motherland.

Russia can now also meddle in, prop up, buy or influence financial systems around the world. It is reaching out with its vast amounts of cash to "help" other countries hit hard by the financial meltdown -- though in typical Kremlin style, Moscow is extending aid to states it considers politically valuable. In the past, the Kremlin used oligarchs' cash to do this covertly, but since that cash is needed at home, the government is openly targeting other countries' institutions. Russia is getting involved in the financial situations in Iceland, the United Kingdom, Ukraine, Kazakhstan and Georgia, to name a few. But the Kremlin must balance this desire to take advantage of financial tremors around the world with its need to keep the domestic situation stable and plan for the future of Russia's resurgence, amid concerns that its cash flow could soon dry up as energy prices tumble.

Regional trend: As Russia reasserts itself against the West, it has many levers with which to counter the United States in regions such as the Middle East and Latin America. However, Russia's ability to divide the United States' allies in Europe will give it the most success.

Since the war with Georgia, Russia has shown that it is interested in countering the United States' status as global hegemon by strengthening its relationships throughout the world. Moscow has also proved to Washington that it has levers in place to erode the United States' position in the Middle East (which is Washington's primary focus) and in Latin America (which is in the United States' backyard). But Russia will not push its ability to meddle with Middle Eastern countries like Iran too far; Moscow does not want a strong Tehran in the long run, and Washington could seriously lash back at the Russians. Moscow also knows that its actions in Latin America are mainly symbolic in that the efforts needed for real military, energy, grassroots or political moves would be enormous and would not benefit Russia much. However, this does not mean Moscow's friendship is not incredibly important to those in Latin America looking for their own leverage against Washington.

It is in Europe where Russia's moves against the West will be felt the most. In short, the Europeans are splitting apart and much of it has to do with Russia -- a situation Moscow is trying to magnify. Russia is already using Europe's economic instability to pit the countries against each other. But Moscow is also undermining NATO, a fact that will be highlighted when the alliance meets in December to discuss Russia and the possibility of extending membership action plans to Georgia and Ukraine. Germany has already staunchly come out against this Washington-initiated plan and is also discussing the possibility of a private security agreement with Russia, a major shift toward Berlin's usual role when Europe is split. But Russia also has its customary levers, like energy, to use in Europe; energy deals with Germany, the Czech Republic, Lithuania and Ukraine will still be up in the air in the next quarter.

Middle East

Regional trend: The United States has successfully forced the countries that made al Qaeda possible into the American alliance structure. It will now use that structure to clamp down on those still resisting American power. In doing so, it might inadvertently trigger tensions with Israel.

Regional trend: The Russo-Georgian war interrupted a window of opportunity for the Iranians and the United States to make headway in their negotiations over Iraq. With a U.S. political transition approaching, these negotiations will remain in limbo through the next quarter.

In writing our third-quarter forecast, Stratfor had many reasons to be optimistic about several major trends in the Middle East. We calculated that as the U.S. election season wound down, the United States and Iran would be approaching the endgame in their negotiations over Iraq. After all, Iran's supreme interest in consolidating Shiite control over Iraq, the United States' strategic interest in freeing up its forces from Iraq, and the winding down of violence in Iraq over the past year -- made possible in part by Iran's cooperation in taming its Shiite militant proxies -- laid the foundation for the United States and Iran to reach a rapprochement sooner rather than later.

For our fourth-quarter forecast, however, we are far less optimistic about the United States and Iran coming to any sort of final understanding, at least in the short term. Following the Russo-Georgian war that took place in the third quarter, the United States more urgently wants to end the war in Iraq in order to free up U.S. forces for more pressing concerns in Eurasia and the Pakistan/Afghanistan theater. The Iranians, on the other hand, have all the more reason to stall in talks with Washington. Iran knows that in the face of a resurgent Russia, the United States will worry about Moscow using the Middle East as another theater for challenging the West, namely by providing advanced weapons systems to a country like Iran. With the added leverage of Russian backing, the Iranians could push for a better deal with the Americans.

But while Iran stalls, the United States is losing interest. It appears that Washington does not feel nearly as pressured as it previously did to deal with the Iranians over Iraq, and the political and military reality in Iraq has shifted substantially over the past two years. In October 2006, a month prior to U.S. congressional elections, Iran significantly escalated Shiite militia attacks in Iraq in an attempt to force a U.S. withdrawal, and it could have used its Shiite militant proxies to trigger a civil war. Now, however, these militias either have been fully integrated into the Iraqi security apparatus (as in the case of the Badr Brigade) or have disintegrated to the point where they are no longer an effective force (as in the case of the Mehdi Army). Much of Iran's current ability to wield influence in Iraq comes through its political and economic links as well as from small groups of well-trained special operations units, such as Hezbollah in Iraq.

While the United States still has a strategic interest in reaching some level of understanding with the Iranians over Iraq, it no longer faces an immediate threat of Iran triggering civil war in the country. This gives Washington a lot more leverage in dealing with Iran, as well as more time and space to concentrate on other, more pressing issues.

In the coming quarter, Iran will not be the United States' main focus in Iraq; Washington will be too preoccupied with its own political transition, and the Iranians will need some time to work out their next steps in Iraq with a new U.S. administration. Instead, the United States will be heavily involved in the internal Iraqi political scene, working to undermine Iranian influence in Baghdad by exploiting deep rifts within the Shiite political community and reasserting Sunni political strength in provincial elections, which are to be held before Jan. 31, 2009. The surrounding Arab states, for the most part, will be in lockstep with the United States in pursuing this strategy.

Iran will use its remaining militant proxies to try and influence the results of the upcoming elections, mainly through bribes and assassination attempts against select candidates. Infighting among Shiite parties, particularly in the south, is expected to flare as Iran tries to accuse the United States of destabilizing Iraq -- a move meant to bolster Iraqi opposition to the Status of Forces Agreement (SOFA), which would provide the legal basis for U.S. troop presence beyond December, when a U.N. mandate runs out. With Iraqi politicians holding out for political and security guarantees from the incoming U.S. administration, it will be difficult for the United States to get the SOFA signed by the December deadline. But Washington is still on course to maintain a military presence in Iraq that is large enough to counterbalance Iran for at least the medium term.

While Iran will be looking to boost its leverage in relation to the West this quarter, it is unlikely to find a dependable ally in Moscow. The Russians have signaled in several different ways that they could step up arms deals and covert operations in the Middle East to undermine Western interests. But with the Israelis and the Turks playing defense and Moscow exhibiting more of a cautious attitude in its actions against the United States in this region, we expect Russian activity in the Middle East this quarter to be more talk than action.

Regional trend: Syria has found a role in the tightening Arab-U.S. alliance, and it will take concrete steps toward a peace deal with Israel that will both reassert Syrian influence in Lebanon and defang Hezbollah.

In our previous quarterly forecast, we anticipated rapid progress in Syria-Israel peace negotiations. The talks were moving at a healthy pace in the first part of the quarter, but paused after the Russo-Georgian war as Syria saw the opportunity to boost its negotiating leverage by reaching out to the Russians. Syria will continue to flirt with Moscow, but Israel and Turkey (which is mediating the peace talks) have been holding their own negotiations with the Russians and have so far kept the Russians at bay. Syria is still in many ways committed to these peace talks, but any major progress is unlikely until Israel puts its political house in order this quarter. Israeli political horse-trading is in full swing, and early elections could still be called, but Stratfor's bet is that Kadima leader Tzipi Livni will form a coalition and stave off early elections to prevent a political comeback by the far-right Likud party, allowing for progress later in the quarter on the Israel-Syria talks.

While Israel sorts out these issues, the Syrian regime will move ahead in its plans to reassert its hegemony over Lebanon. Any peace deal with Israel would inevitably include a guarantee of Syrian domination over Lebanon in exchange for the dismantling of Hezbollah's military arm to secure the Israeli northern frontier. Though the peace talks with Israel are currently in flux, the Syrians are wasting no time laying the groundwork for a possible military intervention in Lebanon by instigating attacks through militant proxies. Syria will take its time in implementing this strategy. Attacks on both sides of the Lebanese-Syrian border are likely to escalate, but the Syrians are unlikely to make any overt moves in Lebanon this quarter. Syria will also be on guard for Iranian attempts to destabilize the Syrian regime as Iran's main militant proxy, Hezbollah, gets backed into a corner.

Regional trend: Turkey is emerging as a major regional power and in 2008 will begin to exert influence throughout its periphery -- most notably in northern Iraq.

Our annual forecast on Turkey's regional expansion is on track and was reinforced this past quarter by Russia's actions in Georgia. Turkey is a traditional stakeholder in the Caucasus and does not like the idea of the Russians throwing punches in this region, especially when doing so threatens Turkey's economic standing as the main energy hub for Europe. The Turks, therefore, are in a diplomatic frenzy to reassert their influence in the Caucasus, even going so far as to kick-start the normalization process with longtime foe Armenia. Using adroit diplomacy, Turkey will work aggressively this quarter to block Russian destabilizing actions in the Middle East and hold its ground against Moscow in the Caucasus. Turkey is not looking for a fight with Moscow, but it wants to show that it will not be toothless in the face of further Russian aggression. (Indeed, Turkey is the state with the most tools to counteract Russian expansionism.)

Energy diplomacy will be a big theme this quarter, as the Turks will use their relations with Azerbaijan, Iran and even Armenia to promote themselves as the alternative to Russia in the Caucasus. Both Armenia and Iran will be tempted by the idea of establishing potentially lucrative energy links with Turkey to access the European market, though any such deals would face substantial political obstacles.

In northern Iraq, Turkey will become more aggressive in pursuing Kurdish rebels and implementing an informal buffer zone along the Turkish-Iraqi border. Turkish actions in northern Iraq will serve more than Ankara's internal security interests; Turkey also has deep political interests in keeping Iraqi Kurdistan and the Kirkuk issue in check as negotiations in Baghdad intensify this quarter.

Europe

Regional trend: After exactly 60 years of trying to reshape itself under the aegis of the European Union, Europe in 2008 will return to an earlier geopolitical arrangement: the Concert of Powers.

The decade-long Stratfor forecast that the European Union will slowly evolve from a Pan-Continental government to a glorified free trade zone is on track. Europe has indeed returned to an arrangement more reminiscent of the Concert of Powers, with France and Germany squabbling over leadership, newcomer Poland rising in status as the next leader and the traditional power of the United Kingdom missing in action. This has played out on all levels, both within the European Union and in foreign relations. Russia has seized the opportunity to magnify the cracks in the European Union, while the United States is now locked into alliances with actors that are constantly disagreeing, weakening Washington's ability to rally forces around any particular agenda -- particularly in dealing with the Russians.

Regional trend: As the traditional geopolitical arrangement similar to the Concert of Powers returns, Europe is being wrecked domestically, economically, institutionally and internationally. This trend in the fourth quarter is caused partly by the return of the old relationships, but also by the global financial crisis and a resurgent Russia.

Regional Trend: The financial crisis will continue to shatter Europe economically, as each state fends for itself in the absence of a Pan-EU decision.

Nearly every European country entered the fourth quarter in a recession, and this situation will not change through at least the end of the year. The European Central Bank (ECB) has done a decent job thus far, but it cannot regulate banks in Europe, so each state will have to come up with its own rules -- further undermining the ECB and the European Union. An EU-wide plan is simply impossible, because there is no institution able to enforce such a decision and each state is primarily concerned with itself.

Bailouts have become routine in Europe, but the fourth quarter will be about European governments attempting to prevent banks from actually failing, which could break the entire system. The less economically and financially advanced countries, which happen to be mainly on the eastern side of the Continent, are most at risk. Central and Eastern Europe are highly dependent on foreign banks and capital -- capital that will be called home, mainly to Western Europe, to help stabilize its native banking systems. The countries most vulnerable to economic crashes are Estonia, Latvia, Lithuania, Slovenia, Bulgaria, Hungary, Croatia, Slovakia, Romania and Serbia. France and Italy are also vulnerable but are better able to handle the crisis due to the sheer size of their economies.

In the fourth quarter, many countries will be reassessing the benefits and drawbacks to being part of the European Union, and nations that are considering joining the eurozone will weigh their priorities as well. European countries will also be reassessing their budgets, with many cuts in programs and funding on the table. This could lead to even more political and social volatility in all European countries. These potential cuts and thin wallets are coming in the most financially stressful season for Europe, as energy costs are high due to cold weather and Europe's largest energy supplier, Russia, is preparing to raise energy prices at the end of the year. European leaders are facing many very difficult and dangerous decisions that will shape not only the fourth quarter, but the years to come.

Regional trend: Europe is divided -- politically, economically and regarding security -- on how to respond to a resurging Russia.

The topic of Russia, and particularly how to respond to Moscow after the Russo-Georgian war, is dividing Europe even further. Politically, many Western European countries have been looking for ways to neutralize the Russian threat. Some nations, like the Czech Republic, Poland and the Baltic states (though Lithuania could soon reverse its opinion on Russia), are preparing to confront Moscow, while others are strengthening their ties with Russia in order to avoid becoming casualties of Moscow's next moves.

Economically, Europe is divided because the squeeze it is feeling from the global financial crisis is being compounded by Russian moves in the financial sector. Moscow has moved its cash around in a bid to influence financial institutions in certain strategic countries. Russia is also in negotiations with much of Central and Eastern Europe over energy supplies and prices for the next year, and Moscow has told most countries to prepare for excruciatingly steep price hikes. This puts Moscow in a position of great strength from which to negotiate with the countries that need lower energy prices during the current financial crisis.

The Europeans are also divided over how their security alliances should respond to a resurging Russia. The West (especially Washington) failed to respond meaningfully to the Russo-Georgian war -- a fact that Moscow hopes to use to prove the inherent weakness of the West's security club, NATO. Berlin and Paris have already publicly recognized the weakness and believe that this is not the time to stand up to Russia, as NATO is entrenched in Afghanistan and the United States has the additional burden of Iraq. These two European heavyweights are leading the resistance against Washington over extending NATO membership plans to the former Soviet states of Georgia and Ukraine. Countries like Poland and the Baltics are still behind the U.S. plans, but going into the December summit, NATO members -- especially those in Europe -- are anything but in agreement.

Latin America

Regional trend: Aiming to sow instability in the U.S. backyard, Russia will focus much of its attention on Latin America, where a number of Cold War-era tactics are likely to come into play.

The Russian invasion of Georgia in the third quarter was a wake-up call to the West that Russia was resurging. Shortly after the war, Russia arrived on the scene in Latin America. Having promised at least $1 billion in arms aid to Venezuela and reopened dialogue with Cuba over a return to Cold War-era alliances, Russia clearly intends to direct Washington's attention toward the U.S. southern flank. No longer constrained by a need to promote an international communist ideology to gain a foothold in the region, Russia will focus more on generating instability in Latin America -- a pastime that could lead to a resurgence of Soviet-era militias.

Several Latin American states, including Venezuela, Nicaragua, Bolivia and Ecuador, show promise as Russian allies. States that are vulnerable to Russian maneuvering include, at the very least, Colombia, Peru and Mexico. With economic troubles on the rise across the region, this list could expand, and with a lame-duck administration and no clear Latin America policy to begin with, the U.S. government will be slow to respond this quarter.

Cuba is critical to the question of Russian resurgence not just for its historical relations with Russia, but also for its strategic location at the mouth of the Caribbean. Cuba is trying to both encourage the United States to lift the trade embargo as well as urge Russia to actually put its money where its mouth is in promised investments. Which way Cuba swings will depend on whether the incoming U.S. administration gives any indication that the embargo could be lifted. Otherwise, the Russians will have a greater political opening in Cuba to exploit. For the fourth quarter, however, Cuba will mostly spend its time feeling out Washington's and Moscow's intentions without making any big moves.

Regional trend: The U.S. financial crisis will contribute to a long-term economic downturn in Latin America.

The impact of the global financial crisis on Latin America boils down to two basic factors: the shrinking credit market and falling commodity prices. Latin America is largely dependent on foreign capital for the infrastructural and industrial development that allows the region to produce the primary materials it relies on for income. The relative boom of the past decade rode high on the back of increased industrial production the world over, which created higher demand for Latin American minerals, and on rising food prices, which injected cash into agriculture-dominated economies such as Argentina's.

But as the global economy slows in the wake of the financial crisis, there will be lowered demand for primary materials. This will have a combined effect. For importer states, lower commodity prices, especially on food, are welcome news. But for major commodity producers, such as Venezuela (oil) and Argentina (agriculture), this spells disaster for local economies and government budgets. Though the region is less exposed to the U.S. financial crisis than either Europe or Asia, Latin America is facing an overall economic slowdown. Though widespread financial collapse is unlikely to occur in the fourth quarter, the strains will become apparent.

Regional trend: Brazil is rising as the continental hegemon of South America.

With more oil and natural gas discoveries announced in the past quarter, Brazil is still on track to become a regional superpower in the coming decade, but it will face some challenges in this upcoming quarter. Though blessed with substantial monetary reserves, Brazil faces a slowdown along with the rest of Latin America as the global economy shrinks and access to international credit withers.

Regional trend: Crises are brewing in Latin America's left-wing bloc.

This trend continued unabated in the third quarter, although the only state in which tensions came to a head was Bolivia. The evolution of Bolivian lowland pro-autonomy groups toward a more activist role will be defined next quarter. Though they could be willing to make peace with Bolivian President Evo Morales' government, the odds are not good. In the fourth quarter, Morales will try to push through the enactment of a constitutional referendum that would cement his socialist policies. The opposition will use this opportunity to stage further unrest.

In Argentina, the economy is suffering under President Cristina Fernandez de Kirchner's administration. A lifting of price controls on the edges of the economy could continue, but comprehensive reform is unlikely. Over the next quarter, the agricultural sector will ratchet up pressure on the government to reduce price caps so that it can operate profitably. But falling commodity prices, while helping to contain rising inflation, cut into government income, making it all the more difficult for Buenos Aires to adequately address its economic ailments. The credit crunch has already led Argentina to call off its initial offer to pay back debt to the Paris Club. Other signs of fiscal strain will become evident over the next quarter, bringing Argentina closer to a day when it will once again no longer be able to service its debt or prevent an economic crisis.

Meanwhile, in Venezuela, municipal and state-level elections are slated for Nov. 23. While domestic opposition against Venezuelan President Hugo Chavez is strengthening, the president has already taken action -- by barring more than 200 opposition politicians -- to ensure he makes it through these elections in one piece. Once the elections are over, economic issues will come to the fore. We will likely see a grasping at straws for energy, but this will become increasingly difficult, if not impossible, as credit shrinks and oil prices continue to fall. Although the economy will probably hold for the next quarter, the cracks will be evident. The Russians will remain active in Venezuela, particularly in military cooperation, and signs that Chavez is a conduit for Russian arms transfers to the rest of the region could also come to light.

Regional trend: Mexico is facing a moment of truth in the government's war against the drug cartels.

Mexico's security situation is deteriorating. The third quarter showed an emerging trend of public opinion turning against the violence -- although not necessarily against Mexican President Felipe Calderon. As violence rises, and particularly if civilian casualties become more prevalent, public outcry will increase over the next quarter. For now, the public's discontent is working in the government's favor. But there is a slight possibility that Mexico's citizens will decide the war has failed and start pressuring Calderon. This could erode Mexico's ability to use all its forces against the cartels for fear of backlash. In the past quarter, we did not see any indications that Mexico City felt pressured enough to strike a truce with the cartels to save the country's territorial core, nor any evidence of the cartels striking a truce with each other to place the government on the defensive. But these scenarios are not impossible as the security situation continues spiraling out of control.

Mexico is also particularly vulnerable to Russian covert activity. If the Russians become more active in Mexico, organized criminal activity is likely to increase, though this will be difficult to distinguish from ongoing cartel activity. We will be watching for any signs of an uptick in organizational capacity or tempo of operations in groups like the Popular Revolutionary Army, as the potential exists for Russia to tap into such left-wing organizations to create security problems on the southern U.S. border.

South Asia

Regional trend: The Pakistani army/state will hold together even as confusion and distractions in Islamabad greatly reduce the government's ability (and willingness) to rein in jihadists. Pakistan will be forced to decide whether it is more afraid of NATO forces or of its own militants. It will opt to target the militants, however halfheartedly, rather than make a stand against NATO's incursions into territory that is nominally under Islamabad's writ.

As the jihadist insurgency spread deeper into the Pakistani interior, U.S.-Pakistani relations came to a head in the third quarter, with Pakistani forces taking direct shots at U.S. forces along the Pakistani-Afghan border. But as we expected, the Pakistanis could not go too far in pushing back U.S. forces. Toward the end of the quarter, it became clear that the Pakistani political and military leadership was at least making some attempt to comply with U.S. demands and purge Pakistan's intelligence apparatus, the Inter-Services Intelligence, of jihadist sympathizers while committing more firmly to military operations against al Qaeda and Taliban forces in the tribal areas.

But there is still a lot more work to be done in this theater. With U.S. Gen. David Petraeus now at the helm of Central Command, the evolving U.S. strategy for Pakistan and Afghanistan will likely entail devoting more U.S. forces to Afghanistan and engaging in complex political negotiations with certain Taliban factions, similar to the U.S. policy pursued in Iraq.

For the next quarter, however, little is expected to change on the ground militarily. The United States simply will not have sufficient forces to make a meaningful difference in the Pakistan/Afghanistan theater in the short term. While U.S. forces can escalate cross-border operations into Pakistan, the levels of intrusion will not grow if the United States lacks the forces to back them up. The region also will be entering the winter months, when the fighting on both sides is expected to drop significantly, giving the Taliban and al Qaeda more time to recuperate. Though the United States has announced its intention to continue conducting offensive operations through the winter, the operations will still be limited in scale.

During the winter lull, the bigger focus will be on working toward a negotiated settlement with select factions of the Taliban. Talks involving the Taliban, the Karzai government, the Tajik-dominated opposition, Saudi Arabia, Pakistan, Iran, NATO and the United States will intensify in coming months. This process will be about identifying elements within the Taliban movement that would be willing to do business at a time when the Taliban feels it has the upper hand and thus is not under significant pressure to negotiate. Nonetheless, the mere idea of negotiations taking place will cause existing rifts within the jihadist insurgency to widen. The United States will rely heavily on Saudi Arabia to use its political and financial clout with the Taliban to ensure progress on the negotiating front.

The Pakistanis, on the other hand, will be too consumed with domestic ailments to contribute in any significant way to U.S. efforts in fighting the insurgency. Pakistan's civilian government is caught between fighting anti-Islamabad jihadist forces and working with pro-Islamabad Afghan Taliban. Continued unilateral cross-border U.S. strikes against al Qaeda and its Pashtun allies in Pakistan will further constrain Islamabad's options as domestic dissent continues to rise. Compounding matters is the fact that Pakistan is sliding toward bankruptcy and is now dependent on bailouts and bartering tactics to make it through this quarter without collapsing financially. Pressure from the insurgency and the deteriorating economic situation will further threaten Pakistan's internal stability and raise the potential for a rift to emerge between the civilian government and the army. Overall, Pakistan will institutionally remain in disarray, and fragmentation of the state will worsen in the coming quarter.

Regional trend: India's roller-coaster policies on everything from tax regimes to special economic zones to basic infrastructure are proving that the idea of "Shining India" is a myth and will lead to waning foreign investment.

The global financial crisis that spread in the third quarter only reinforced our forecast that India's attractiveness to foreign investors would significantly wane this year. Though India's banking sector is fairly insulated and not as vulnerable to the financial crisis as those of other Asian countries, it is more than likely to experience a drop in capital inflows and foreign direct investment in the medium to longer term as foreign companies, particularly those based in the United States, are forced to cut back on their overseas operations.

Though India is unlikely to feel a devastating economic impact in the short term, its problems stemming from the financial crisis will be mainly political. Rising inflationary pressures will only add to the opposition's strength in stifling the ruling Congress party at a time when India is also dealing with heightened religious tension and increasingly frequent, albeit low intensity, attacks by more localized Islamist militant cells. On the foreign policy front, India also will be largely politically hamstrung. Securing the civilian nuclear deal with the United States was a huge feat for India's Congress in addressing the country's energy security, and it puts India on a path toward greater strategic cooperation with the global superpower. At the same time, New Delhi cannot politically afford to take any big or overt steps in line with U.S. foreign policy for some time, though it will be closely watching for signs of a complete security and economic meltdown in Pakistan in search of both threats and opportunities.

India also will be keeping its eye on Bangladesh, where national elections are supposed to be held Dec. 18. With the Bangladeshi military tightening its grip over the government, the country's two main rival political leaders have threatened to boycott the polls, raising the potential for the elections to be delayed. Without the participation of these two leaders, there is a high probability of Bangladesh returning to its usual state of political violence and chaos ahead of the polls.

India also has security concerns to its south in Sri Lanka, where the military has made significant advances in its war of attrition against Liberation Tigers of Tamil Eelam rebels in the north. While the military's successes are often exaggerated, it stands a decent chance of overtaking Tiger strongholds in the strategic Jaffna Peninsula to the north. The Tigers will be cornered at that point, but they will not be a vanquished force. The Sri Lankan military has made comparable advances into Tiger-held territory in the past, only to see the Tigers make a significant comeback after several years. As they continue to get beaten in the north, the Tigers will make a stronger attempt to carry out attacks inside Colombo in an attempt to prove to their constituency that they are still viable.

East Asia

Regional trend: The Chinese government postponed any key reforms in 2008 until after the Olympics in August, but as Beijing now begins tackling these issues, it is confronted by a global financial crisis that will convolute all its reform plans.

Thus far, the Olympics have dominated 2008 in China, with Beijing consumed with quashing any disruptions or embarrassments that would cast a shadow over the country during its time in the global spotlight. While Beijing was distracted, issues like economic and social disparity, corruption and rising domestic frustrations festered. Beijing was convinced that as soon as the Olympics were over, it could finally address these issues with full force. But the reforms China makes will not necessarily be the ones it originally planned, as the global economic slowdown will interfere.

Many key debates are raging behind the scenes of China's central government over issues like rural development, informal and state banking, the central bank's short- and long-term lending rates, the yuan's exchange, price controls, the growth of small- to medium-sized businesses, international trade and the export sector, and energy supply and policy. These debates have put a dangerous amount of stress on the Communist Party of China and the country's top leadership.

The largest debate has been over to what degree to redistribute wealth, particularly between the wealthy coastlands and the much poorer internal regions of the country. The divide between China's mostly poor rural masses and its wealthier urban elite has generated considerable tension, causing worry among the nation's leaders about social stability and sustainable economic growth. Attempts at massive renovations and development projects in the interior, meant to boost agriculture's role in the Chinese economy, were supposed to trigger a series of policy actions that would play out through the end of the year.

But the global financial crisis will force Beijing to focus on ensuring internal stability, employment, business operations and the ability to hold onto its own cash, and this means Beijing must turn its attention back to the coast, the country's moneymaker. China is in a conundrum: It needs to redistribute wealth to guarantee internal stability, but it cannot do that if the wealth is not coming in. The financial meltdown's effects in the West are impacting China's export sector and putting at risk China's businesses (which are already seeing thin profit margins) and laborers (who are on the brink of financial ruin and unemployment). China will have to basically run in place; the economy might look like it is growing, but the trickle-down effect will be barely sustainable.

China will respond by promoting growth through cheap credit and big public spending, as it is afraid of unemployment getting out of control. It will be more important for China to use its reserves to contain the internal situation than to contribute funds to other countries, including the United States. China needs all the excess liquidity in its system to go toward appeasing the social groups most likely to be affected negatively by the economic slowdown.

Regional trend: The global financial crisis will also hit East Asia's other two economic powerhouses, Japan and South Korea, along with the smaller Southeast Asian states -- though the major effects will not be seen until the end of the year.

Japan and South Korea are both powerful economies, and both are in dire economic trouble. Japan has massive reserves, but its debt is enormous, its exports are faltering, and now the yen is rising rapidly as the carry trade unwinds, further damaging the export sector. Japan will print money frantically to slow the yen's rise, but will only see moderate success because the crisis is already far too deep. Japan is facing a major recession -- if not the disastrous economic dislocation that awaits it if it proves incapable of reforming its system.

South Korea is also in dire straits. Its economy is hurting because of the won's rapid loss of value as investors withdraw from risky assets. The weakened won will hurt South Korean businesses that are struggling to manage costs while exports fall. Market uncertainty, inflation, poor consumer sentiment and a declining currency will cause South Korean businesses to suffer unless the country is willing to repeatedly dip into its foreign currency reserves to combat the slowdown.

Most of the Asian states have plenty of liquidity due to the nature of their financial systems. The Southeast Asian countries are nervous about their fates but are not thoroughly linked to the outside world, so their economic troubles will have little impact on the rest of the globe. But these nations have not become the hotbed of economic growth they were expected to be; some never recovered from 1997 crisis, while others, like Vietnam, will not see money influxes now. Southeast Asian countries are also highly interlinked through their supply lines and trade, so when one or two economies struggle or slow, the others are hit as well. The credit crunch is causing cash and investment to flow away from them, and their export sectors are flagging. Two states that will be hit hard by this are Singapore and Malaysia, both of which have re-exports making up a large chunk of their exports. This means that even if their strong exports continue, these countries' dependence on others to use them as a subprocessing hub could sting them when other exporters' activities slow. Southeast Asian nations are expected to feel the crush of loss of credit -- just not to the extent of Japan or China. But the ripples of this crisis will likely cause economic slowdowns that could exacerbate social tensions in the region, making for a lot of noise in the fourth quarter.

Africa

Regional trend: In contrast to previous years, there will be little direct involvement from the major outside (or even inside) players in Africa. The one exception will be if Russia has any capacity to meddle in Africa this next quarter. However, Africa is not high on Moscow's list of priorities.

The second- and third-quarter forecasts for Africa predicted that the continent would not see any meaningful direct involvement from the traditional players, whether from the continent or beyond. This situation will continue through the end of the year (though for different reasons than before), with only one possible exception. Most of the big foreign players in Africa -- the United States, France, China, India and Japan -- are completely entangled in the global financial crisis and do not really have the wherewithal to handle any new engagements in Africa.

Moreover, the portfolio investment that Africa recently attracted as a "frontier market" will be constrained as global investors seek to stabilize their investment returns. Startup and junior mining interests will find it difficult to secure financing for mining projects, and while major mining companies will be able to find sufficient financing, slowing demand for commodities will mean that African economies will slow -- or, more to the point, there will be less money for the governments to keep. Interest in Africa's energy and mining sectors will remain high, but cost factors will make investors more selective.

The one possible exception to this trend could be Russia. During the Soviet days, Russia supported liberation movements and governments in Africa (as in Latin America), which it used as proxies against U.S. interests. Thus, Russia already has access to a deep set of networks constructed in Africa during the Cold War. Russia began moving in on Africa during the third quarter, when it began negotiations with the Somalian government on providing military and technical assistance and decided to send a naval vessel to strengthen maritime security off Somalia's piracy-plagued coast. African countries that cooperated with the Soviets during the Cold War did so less out of ideology and more to acquire weaponry, funding and training to fight their own battles. These conflicts and tensions are ongoing in several countries besides Somalia (such Guinea, Mali and Angola) and could help Russia renew both overt and covert relationships in Africa.

Within Africa, the major players are too busy with internal politics to get involved in issues between countries on the continent. Nigeria is still trying to manage the Niger Delta, South Africa is busy laying the groundwork for elections, and in Angola the government is concerned with consolidating its grip on power at home and either co-opting or silencing its opponents.

In Nigeria, the 2007 pact that gave the Ijaw tribe in the Niger Delta the vice presidency and led to a decrease in attacks against the region's energy infrastructure will be tested -- but not overturned -- in the fourth quarter. Northern-backed President Umaru Yaradua will move to consolidate his position in Abuja by naming a new Cabinet and purging his government of ministers appointed by his predecessor, Olusegun Obasanjo. Yaradua's moves will catch the attention of the Ijaw in the south, however, and should they believe they have lost their gains in Abuja -- for instance, if Vice President Goodluck Jonathan loses his influence -- all bets for energy security in the Niger Delta are off.

The wild card is Yaradua's frail health. If it forces him to step down, a struggle over succession will ensue, and the Ijaw will use their key weapon -- militant proxies that launch attacks in the Niger Delta energy sector -- to secure their interests in Abuja. A battle threatening all energy production throughout the Niger Delta would also raise the stakes higher than they were in 2007, demanding a military solution rather than a combination of diplomacy and economic incentives. The carnage that would result from Abuja trying to impose a military solution in the Niger Delta would be extensive.

In South Africa, the transfer of power from former President Thabo Mbeki to African National Congress President Jacob Zuma will accelerate, though elections likely will not be held early. (National elections are due by mid-2009, when Zuma most likely will push to re-establish South Africa's regional influence.) Until then, it is just regular politicking and electioneering in the country, and this will not significantly alter South Africa's policies or its relative quietude on the continent.

Angola faces more immediate concerns, including lingering tensions with the National Union for the Total Independence of Angola (UNITA) political party and rebels in its oil-rich Cabinda province. Angola will try to stamp out these rebels in the fourth quarter, following the ruling party's authoritative victory in recent parliamentary elections. The country must also be prepared to face a hostile regime in the neighboring Democratic Republic of the Congo (DRC). The United States could move to counter a possible Russian resurgence in south-central Africa by supporting the Rwandan-backed insurgency in the DRC, which in turn could move to topple the pro-Angolan government of President Joseph Kabila in Kinshasa. Installing a pro-U.S. government in the DRC could then allow the insurgents to use DRC territory to destabilize the pro-Russian Angolan government. Should the Russian arms dealers come calling, they could enflame such a conflict, embroiling Angola, the DRC and Rwanda.

The Real World Order

John Mauldin — Thu, 21 Aug 2008 13:44:44 GMT

"But this time it's different!!!" Any time you hear that from a financial analyst, you should run. Or better still, take the other side of his trade! If you're numerically oriented, you know that patterns tend to revert to the mean. If you're historically oriented, you know that the more things change, the more they remain the same. Can companies really make money selling a product for less than it costs to make - even in volume? Ask Buffett why he sat out the tech boom....

Today I'm passing along a piece from George Friedman, Chief Intelligence Officer at Stratfor. He makes the absolutely compelling argument that issues of war and peace follow these same guidelines. There are ebbs and flows, but war between countries is an inevitable part of history, and it's driven by simple geography. The recent war between Russia and Georgia was precisely such a "reversion to the mean," double-entendre fully intended.

Navigating financial markets requires an understanding of the geopolitical issues - the war & peace - that drive them. What does this war mean for Russian gas supplies to Europe? What does this war mean for the future of the BTC pipeline? Does this war make Iranian inclusion in global markets more or less likely? Is Russia just "vertically integrating" its control of energy flows with less-than-subtle tools?

You may have seen Stratfor quotations recently in the New York Times, Bloomberg, and Barron's. But personally I need more than just snippets. Quite simply, George's team is the best out there, and I encourage you to take advantage of the special offer that George makes available for my readers. The old Cold War is heating up, and this is no time to be without intelligence on what's coming next and analysis of what it means.

Read the analysis below and get a solid reminder that it's not different this time - or any other.

John Mauldin, Editor
Outside the Box

The Real World Order

By George Friedman

On Sept. 11, 1990, U.S. President George H. W. Bush addressed Congress. He spoke in the wake of the end of Communism in Eastern Europe, the weakening of the Soviet Union, and the invasion of Kuwait by Saddam Hussein. He argued that a New World Order was emerging: "A hundred generations have searched for this elusive path to peace, while a thousand wars raged across the span of human endeavor, and today that new world is struggling to be born. A world quite different from the one we've known. A world where the rule of law supplants the rule of the jungle. A world in which nations recognize the shared responsibility for freedom and justice. A world where the strong respect the rights of the weak."

After every major, systemic war, there is the hope that this will be the war to end all wars. The idea driving it is simple. Wars are usually won by grand coalitions. The idea is that the coalition that won the war by working together will continue to work together to make the peace. Indeed, the idea is that the defeated will join the coalition and work with them to ensure the peace. This was the dream behind the Congress of Vienna, the League of Nations, the United Nations and, after the Cold War, NATO. The idea was that there would be no major issues that couldn't be handled by the victors, now joined with the defeated. That was the idea that drove George H. W. Bush as the Cold War was coming to its end.

Those with the dream are always disappointed. The victorious coalition breaks apart. The defeated refuse to play the role assigned to them. New powers emerge that were not part of the coalition. Anyone may have ideals and visions. The reality of the world order is that there are profound divergences of interest in a world where distrust is a natural and reasonable response to reality. In the end, ideals and visions vanish in a new round of geopolitical conflict.

The post-Cold War world, the New World Order, ended with authority on Aug. 8, 2008, when Russia and Georgia went to war. Certainly, this war was not in itself of major significance, and a very good case can be made that the New World Order actually started coming apart on Sept. 11, 2001. But it was on Aug. 8 that a nation-state, Russia, attacked another nation-state, Georgia, out of fear of the intentions of a third nation-state, the United States. This causes us to begin thinking about the Real World Order.

The global system is suffering from two imbalances. First, one nation-state, the United States, remains overwhelmingly powerful, and no combination of powers are in a position to control its behavior. We are aware of all the economic problems besetting the United States, but the reality is that the American economy is larger than the next three economies combined (Japan, Germany and China). The U.S. military controls all the world's oceans and effectively dominates space. Because of these factors, the United States remains politically powerful - not liked and perhaps not admired, but enormously powerful.

The second imbalance is within the United States itself. Its ground forces and the bulk of its logistical capability are committed to the Middle East, particularly Iraq and Afghanistan. The United States also is threatening on occasion to go to war with Iran, which would tie down most of its air power, and it is facing a destabilizing Pakistan. Therefore, there is this paradox: The United States is so powerful that, in the long run, it has created an imbalance in the global system. In the short run, however, it is so off balance that it has few, if any, military resources to deal with challenges elsewhere. That means that the United State s remains the dominant power in the long run but it cannot exercise that power in the short run. This creates a window of opportunity for other countries to act.

The outcome of the Iraq war can be seen emerging. The United States has succeeded in creating the foundations for a political settlement among the main Iraqi factions that will create a relatively stable government. In that sense, U.S. policy has succeeded. But the problem the United States has is the length of time it took to achieve this success. Had it occurred in 2003, the United States would not suffer its current imbalance. But this is 2008, more than five years after the invasion. The United States never expected a war of this duration, nor did it plan for it. In order to fight the war, it had to inject a major portion of its ground fighting capability into it. The length of the war was the problem. U.S. ground forces are either in Iraq, recovering from a tour or preparing for a deployment. What strategic reserves are available are tasked into Afghanistan. Little is left over.

As Iraq pulled in the bulk of available forces, the United States did not shift its foreign policy elsewhere. For example, it remained committed to the expansion of democracy in the former Soviet Union and the expansion of NATO, to include Ukraine and Georgia. From the fall of the former Soviet Union, the United States saw itself as having a dominant role in reshaping post-Soviet social and political orders, including influencing the emergence of democratic institutions and free markets. The United States saw this almost in the same light as it saw the democratization of Germany and Japan after World War II. Having defeated the Soviet Union, it now fell to the United States to reshape the societies of the successor states.

Through the 1990s, the successor states, particularly Russia, were inert. Undergoing painful internal upheaval - which foreigners saw as reform but which many Russians viewed as a foreign-inspired national catastrophe - Russia could not resist American and European involvement in regional and internal affairs. From the American point of view, the reshaping of the region - from the Kosovo war to the expansion of NATO to the deployment of U.S. Air Force bases to Central Asia - was simply a logical expansion of the collapse of the Soviet Union. It was a benign attempt to stabilize the region, enhance its prosperity and security and integrate it into the global system.

As Russia regained its balance from the chaos of the 1990s, it began to see the American and European presence in a less benign light. It was not clear to the Russians that the United States was trying to stabilize the region. Rather, it appeared to the Russians that the United States was trying to take advantage of Russian weakness to impose a new politico-military reality in which Russia was to be surrounded with nations controlled by the United States and its military system, NATO. In spite of the promise made by Bill Clinton that NATO would not expand into the former Soviet Union, the three Baltic states were admitted. The promise was not addressed. NATO was expanded because it could and Russia could do nothing about it.

From the Russian point of view, the strategic break point was Ukraine. When the Orange Revolution came to Ukraine, the American and European impression was that this was a spontaneous democratic rising. The Russian perception was that it was a well-financed CIA operation to foment an anti-Russian and pro-American uprising in Ukraine. When the United States quickly began discussing the inclusion of Ukraine in NATO, the Russians came to the conclusion that the United States intended to surround and crush the Russian Federation. In their view, if NATO expanded into Ukraine, the Western military alliance would place Russia in a strategically untenable position. Russia would be indefensible. The American response was that it had no intention of threatening Russia. The Russian question was returned: Then why are you trying to take control of Ukraine? What other purpose would you have? The United States dismissed these Russian concerns as absurd. The Russians, not regarding them as absurd at all, began planning on the assumption of a hostile United States.

If the United States had intended to break the Russian Federation once and for all, the time for that was in the 1990s, before Yeltsin was replaced by Putin and before 9/11. There was, however, no clear policy on this, because the United States felt it had all the time in the world. Superficially this was true, but only superficially. First, the United States did not understand that the Yeltsin years were a temporary aberration and that a new government intending to stabilize Russia was inevitable. If not Putin, it would have been someone else. Second, the United States did not appreciate that it did not control the international agenda. Sept. 11, 2001, took away American options in the former Soviet Union. No only did it need Russian help in Afghanistan, but it was going to spend the next decade tied up in the Middle East. The United States had lost its room for maneuver and therefore had run out of time.

And now we come to the key point. In spite of diminishing military options outside of the Middle East, the United States did not modify its policy in the former Soviet Union. It continued to aggressively attempt to influence countries in the region, and it became particularly committed to integrating Ukraine and Georgia into NATO, in spite of the fact that both were of overwhelming strategic interest to the Russians. Ukraine dominated Russia's southwestern flank, without any natural boundaries protecting them. Georgia was seen as a constant irritant in Chechnya as well as a barrier to Russian interests in the Caucasus.

Moving rapidly to consolidate U.S. control over these and other countries in the former Soviet Union made strategic sense. Russia was weak, divided and poorly governed. It could make no response. Continuing this policy in the 2000s, when the Russians were getting stronger, more united and better governed and while U.S. forces were no longer available, made much less sense. The United States continued to irritate the Russians without having, in the short run, the forces needed to act decisively.

The American calculation was that the Russian government would not confront American interests in the region. The Russian calculation was that it could not wait to confront these interests because the United States was concluding the Iraq war and would return to its pre-eminent position in a few short years. Therefore, it made no sense for Russia to wait and it made every sense for Russia to act as quickly as possible.

The Russians were partly influenced in their timing by the success of the American surge in Iraq. If the United States continued its policy and had force to back it up, the Russians would lose their window of opportunity. Moreover, the Russians had an additional lever for use on the Americans: Iran.

The United States had been playing a complex game with Iran for years, threatening to attack while trying to negotiate. The Americans needed the Russians. Sanctions against Iran would have no meaning if the Russians did not participate, and the United States did not want Russia selling advance air defense systems to Iran. (Such systems, which American analysts had warned were quite capable, were not present in Syria on Sept. 6, 2007, when the Israelis struck a nuclear facility there.) As the United States re-evaluates the Russian military, it does not want to be surprised by Russian technology. Therefore, the more aggressive the United States becomes toward Russia, the greater the difficulties it will have in Iran. This further encouraged the Russians to act sooner rather than later.

The Russians have now proven two things. First, contrary to the reality of the 1990s, they can execute a competent military operation. Second, contrary to regional perception, the United States cannot intervene. The Russian message was directed against Ukraine most of all, but the Baltics, Central Asia and Belarus are all listening. The Russians will not act precipitously. They expect all of these countries to adjust their foreign policies away from the United States and toward Russia. They are looking to see if the lesson is absorbed. At first, there will be mighty speeches and resistance. But the reality on the ground is the reality on the ground.

We would expect the Russians to get traction. But if they don't, the Russians are aware that they are, in the long run, much weaker than the Americans, and that they will retain their regional position of strength only while the United States is off balance in Iraq. If the lesson isn't absorbed, the Russians are capable of more direct action, and they will not let this chance slip away. This is their chance to redefine their sphere of influence. They will not get another.

The other country that is watching and thinking is Iran. Iran had accepted the idea that it had lost the chance to dominate Iraq. It had also accepted the idea that it would have to bargain away its nuclear capability or lose it. The Iranians are now wondering if this is still true and are undoubtedly pinging the Russians about the situation. Meanwhile, the Russians are waiting for the Americans to calm down and get serious. If the Americans plan to take meaningful action against them, they will respond in Iran. But the Americans have no meaningful actions they can take; they need to get out of Iraq and they need help against Iran. The quid pro quo here is obvious. The United States acquiesces to Russian actions (which it can't do anything about), while the Russians cooperate with the United States against Iran getting nuclear weapons (something Russia does not want to see).

One of the interesting concepts of the New World Order was that all serious countries would want to participate in it and that the only threat would come from rogue states and nonstate actors such as North Korea and al Qaeda. Serious analysts argued that conflict between nation-states would not be important in the 21st century. There will certainly be rogue states and nonstate actors, but the 21st century will be no different than any other century. On Aug. 8, the Russians invited us all to the Real World Order.

A Mystery in the Middle East

John Mauldin — Thu, 10 Apr 2008 16:37:54 GMT

This is a Special Edition of Outside the Box from my friend George Friedman and Stratfor. You've heard me say before that these guys see the world in a different way, but this piece just makes it crystal clear. There are serious rumblings about a...(read more)

War Plans: United States and Iran

John Mauldin — Thu, 01 Nov 2007 19:41:28 GMT

This week in our Special Outside the Box, George Friedman of Stratfor addresses what many believe to be the looming war with Iran, the potential wars' strategic futility, the underlying geopolitical implications, and the inherent threats that abound...(read more)

Israel, Syria and the Glaring Secret

John Mauldin — Fri, 28 Sep 2007 16:43:00 GMT

Introduction One of the things I found out in my recent survey of readers is that many of you really like the special Outside the Box I send every now and then from George Friedman and Stratfor. I share your enthusiasm for the really unique world view...(read more)

The Major Diplomatic and Strategic Evolution in Iraq

John Mauldin — Thu, 09 Aug 2007 16:53:00 GMT

Introduction This week in a Special Outside the Box good friend George Friedman addresses the Byzantine geopolitical ramifications of recent three party discussions between the Americans, Iraqis, and Iranians. With no obvious reason to trust one another...(read more)

Two Busted Flushes: The U.S. and Iranian Negotiations

John Mauldin — Thu, 15 Mar 2007 20:57:00 GMT

Introduction This week's special edition of Outside the Box touches on the strained relationship between the U.S. and Iran as the war in Iraq continues to loom. Bush is nearing the end of his tenure as President and is (as well as has been) seeking...(read more)

Russia's Great-Power Strategy

John Mauldin — Thu, 15 Feb 2007 22:01:00 GMT

Introduction Today's special edition Outside the Box discusses the long-term strategy that Russian President Vladimir Putin is setting in place. Stratfor President George Friedman has written an intriguing article on what he sees as some motives,...(read more)

Rhetoric and Reality: The View from Iran

John Mauldin — Thu, 18 Jan 2007 22:17:00 GMT

Introduction Today's Special Edition of "Outside the Box" by my friends at Stratfor gives us a very insightful analysis of the difference between the rhetoric of Iran and the reality of the world they face. George Friedman, President of...(read more)